This Chart Shows The Stock Market/Bonds Divergence – Mike Swanson (03/02/2021)

Markets are slightly red in pre-market action as we watch this. Perhaps they will trade mixed for a few hours after the open today. There are now rumors that the Federal Reserve will implement an “operation twist” operation instead of yield control. They did this back around 2011 and it involves selling short-term notes and then using the proceeds to buy longer term bonds to flatten out the yield curve. The Fed is getting to the place where it must try to do something.

“The Fed essentially has to place a raised floor in the U.S. economy to keep things that need positive returns alive,” Fed veteran Christopher Whalen, head of Whalen Global Advisory, told CNBC. “No matter how well-intentioned they are, their efforts to engineer things are slowly weakening the system,” he said. “You have another bad auction or two and we’re screwed.”

Over the past week we have seen some big up and down swings in the stock market and they get your attention when they happen, but it’s always best to step back and look at charts going back for months or longer to put such moves in perspective. In fact big sudden swings up and down near a high are actually characteristics of a market going through a stage three topping process.

I usually have a new stock pick of the month to start out each first trading day of the month, but yesterday I did not do that, because I am not sure that this is a good time to be buying new stocks. I want to see the situation stabilize first.

Yesterday I talked about gold and how I think it’s likely to turn around once the stock market falters and then bottom AHEAD of the end of a stock market correction. Hopefully I am wrong and stocks just keep going up for people, but this is what happened in 2018 for instance that Fall. And it happened in 2008 and in the Fall of 2000. However, I want to show you today the most important thing happening in the financial markets now.

That is the negative divergence in the bond market and the US stock market. Take a look at this hourly chart.

On the bottom of this chart is the LQD corporate bond ETF and the TLT ETF for the 20-year Treasury bond. What I want you to notice is what happened.

1)The TLT Treasury bond ETF made a peak in August and went into a slow decline that picked up speed after New Years and then did so even more last week.

2)The LQD ETF continued to stay at a high level and ignored the slow decline in Treasury bonds until New Years, at which time it peaked. In other words the corporate bond market ignored the decline happening in the Treasury bond market. In trading terms this is called a negative divergence.

Now the two ETF’s are basically trading down together. Both are actually below their 150, 200, and 50-day moving averages.

3)People are talking a lot about Treasury bonds and yields now, but they weren’t until just recently, because the stock market didn’t care about them when they were falling last year as the stock market just went up and up.

Once LQD went down with TLT after New Years that became a more dangerous situation and yet the stock market continued to ignore it. That is another negative divergence, because it is something that would eventually matter to stocks if it continued.

And it did continue and so the stock market finally buckled last week, because of it.

What can we take from this?

1)The stock market is getting more volatile. However, for it to blast off and start to rally like it did last year after the election or from July to September would require the LQD corporate bond ETF to rally too.

How likely is that to happen?

Not very much, if you believe inflation is going to tick up from here.

The stock market can drift and float and chop in a best case scenario, but if LQD and TLT fall below their lows of last week that will mean that the dangers to it remain.

There is also a relationship with the TLT and Treasury bond auctions, which take place roughly about once a month on five and ten year bonds. The last one was last week on Thursday.

According to the Wall Street Journal, “Traders said concerning dynamics were evident in a Treasury auction late last week. Demand for five- and seven-year Treasurys was weak Thursday heading into a $62 billion auction of seven-year notes and nearly evaporated in the minutes following the auction, which was one of the most poorly received that analysts could remember.”

Growing budget deficits and inflation concerns are what is causing this. The next auction for 10-year bonds is this Thursday per this calendar.

As for the stock market, it bounced back yesterday, but is now overbought on the 60 minute chart in terms of its stochastics indicator, which is now above 80. That’s the indicator on the top of this chart.

These stochastics indicators give a sell signal when they cross back below 80 after having gone above it. Such signals also are more reliable when they go off in the afternoon then in the morning. It would take the S&P 500 fading below 3880 by today’s close to make that happen. Of course, when the market is in a strong uptrend that doesn’t mean anything as you can see from the action up to mid-February.

But in topping phases and downtrends they do matter. Current support on the Nasdaq remains at 13,000 and is around 3810 for the S&P 500, which now has resistance at 3920. Which levels get broken first will set the stage in the markets for the next few months.

If you got any comments or want to see what others are thinking scroll on below to the bottom of this page (or hit leave comments if you are using a phone to enter that section).

-Mike



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